Difference between short-term TIPS funds?

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watchnerd
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Re: Difference between short-term TIPS funds?

Post by watchnerd » Sun Feb 23, 2020 1:46 pm

garlandwhizzer wrote:
Sun Feb 23, 2020 1:23 pm
ST Treasuriy Funds and MMF also provide some degree inflation protection due to their short durations and rapid turnover, but not as much as with ST TIPS. If rates and inflation rise, nominal bond principal values will decline in direct relationship to their duration so you lose less principal value with short duration. Especially if your nominals are intermediate or long term, ST TIPS are nice to have because unexpected inflation is the chief enemy of bond duration.

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MM + Short TIPS + Long Treasuries

Between mild expected inflation, unexpected inflation, and deflation, something in that mix will do well, while the others lag or suffer.
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Blueskies123
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Re: Difference between short-term TIPS funds?

Post by Blueskies123 » Sun Feb 23, 2020 2:05 pm

Garland beat me to it, and I know many of you know this, but everyone should stop saying TIPs protect you from inflation. You are confusing new people. TIPs protect against UNEXPECTED inflation.
If you find yourself in a hole, stop digging

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watchnerd
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Re: Difference between short-term TIPS funds?

Post by watchnerd » Sun Feb 23, 2020 2:26 pm

Blueskies123 wrote:
Sun Feb 23, 2020 2:05 pm
Garland beat me to it, and I know many of you know this, but everyone should stop saying TIPs protect you from inflation. You are confusing new people. TIPs protect against UNEXPECTED inflation.
Which is why I don't think it's that critical to own TIPS over very short time frames.

The shorter the time horizon, the more 'expected' the inflation is and the more short nominals and cash equivalents factor it in.
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Re: Difference between short-term TIPS funds?

Post by FIREchief » Sun Feb 23, 2020 2:49 pm

Blueskies123 wrote:
Sun Feb 23, 2020 2:05 pm
Garland beat me to it, and I know many of you know this, but everyone should stop saying TIPs protect you from inflation. You are confusing new people. TIPs protect against UNEXPECTED inflation.
Well, if we're trying to be entirely precise, TIPs protect against HIGHER THAN EXPECTED inflation. 8-) If we expect inflation to equal 2%, and it comes in at 1.5%, wouldn't that also be "unexpected" inflation? (which might lead to a nominal treasury returning more in real terms than a TIPS)
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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joeschmo
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Re: Difference between short-term TIPS funds?

Post by joeschmo » Sun Feb 23, 2020 2:58 pm

Thanks all! Do treasuries protect against (≤ expected) inflation in a way that munis do not? That would indicate that I should own some mix of munis, nominal treasuries, and real treasuries - but I'm not sure how to figure out that mix. Right now I imagined 50% short-term TIPS and 50% interm-term munis (for the bond portion of the portfolio).

Also, does Vanguard's research conclude that short-term TIPS help combat all inflation? https://personal.vanguard.com/pdf/ISGCTIPS.pdf

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Re: Difference between short-term TIPS funds?

Post by watchnerd » Sun Feb 23, 2020 3:03 pm

joeschmo wrote:
Sun Feb 23, 2020 2:58 pm
Thanks all! Do treasuries protect against (≤ expected) inflation in a way that munis do not?
There is no such thing as inflation-protected munis.

Otherwise, for a given duration, you're looking at differences in tax equivalent yields.
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Re: Difference between short-term TIPS funds?

Post by Phineas J. Whoopee » Sun Feb 23, 2020 4:10 pm

Blueskies123 wrote:
Sun Feb 23, 2020 2:05 pm
Garland beat me to it, and I know many of you know this, but everyone should stop saying TIPs protect you from inflation. You are confusing new people. TIPs protect against UNEXPECTED inflation.
TIPS are adjusted for any inflation that occurs, expected or unexpected. The question comes in when comparing the nominal return of TIPS vs. the nominal return of nominal Treasuries. If inflation is higher than expected the nominal return of TIPS will be higher. If realized inflation is lower, then the nominal return of nominal Treasuries will be higher.

I think the underlying confusion is between the meanings of real and nominal yields.

PJW

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Re: Difference between short-term TIPS funds?

Post by GettingCloser » Sun Feb 23, 2020 11:25 pm

Northern Flicker wrote:
Sat Feb 22, 2020 7:41 pm
TIPS are not issued in the range of maturities for very many rungs of a ladder. You will have to buy a number of them on the secondary market
As watchnerd pointed out, you don't *have* to buy anything on the secondary market -- you can just build up a ladder over time. I started building my first-phase retirement ladder ten years prior to my target retirement date, using individual ten-year TIPS lots purchased at auction (details here). Although that means it's taking ten years to complete the ladder, it ends up naturally forming a Kitces-style bond tent, for those that like that idea.
where seasoning of principal from inflation adjustments usually means not being guaranteed of getting 100% of principal back at maturity.
For those following along at home, Northern Flicker is referring to a loophole in the way that TIPS' DEflation protection feature applies to individual TIPS bought on the secondary market. If you buy an "old" TIPS on the secondary market that has already had significant inflation adjustment applied, the price you pay will be higher than that TIPS' original auction price (because you the buyer are effectively paying the accumulated inflation adjustment to the seller). That works out just fine if net inflation ends up being zero or positive between your purchase date and that TIPS' maturity date. But if we experience net DEflation between those two dates, you could end up losing a portion of your "principal" because the deflation protection guarantee only applies to the original auction price, versus the higher price that you paid for it.

Of course, that loophole doesn't apply if you buy your TIPS at auction, nor if net inflation between those two dates is zero or positive. Even in the rare cases where it does apply, you still end up getting the same net real return as was determined at the time of auction -- you just would not receive the real return windfall that you would have received had you bought the TIPS at auction.

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Re: Difference between short-term TIPS funds?

Post by joeschmo » Mon Feb 24, 2020 6:55 pm

So is it fair to say that nominal Treasurys* are adjusted for expected inflation only, whereas real Treasurys (TIPS) are adjusted for both expected and unexpected inflation? Is there a source someone could point me to that says this, so I can refer to it in my IPS?

Thanks for all the conversation about this!

* Looks like that rather than Treasuries is the correct spelling.

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Re: Difference between short-term TIPS funds?

Post by watchnerd » Mon Feb 24, 2020 7:05 pm

joeschmo wrote:
Mon Feb 24, 2020 6:55 pm
So is it fair to say that nominal Treasurys* are adjusted for expected inflation only, whereas real Treasurys (TIPS) are adjusted for both expected and unexpected inflation? Is there a source someone could point me to that says this, so I can refer to it in my IPS?

Thanks for all the conversation about this!

* Looks like that rather than Treasuries is the correct spelling.
Adjusted?

No....

The market causes the yield of nominal bonds to fluctuate by changes to the trading value in response to inflation and other economic concerns.
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Re: Difference between short-term TIPS funds?

Post by sycamore » Mon Feb 24, 2020 8:50 pm

joeschmo wrote:
Mon Feb 24, 2020 6:55 pm
So is it fair to say that nominal Treasurys* are adjusted for expected inflation only, whereas real Treasurys (TIPS) are adjusted for both expected and unexpected inflation? Is there a source someone could point me to that says this, so I can refer to it in my IPS?

Thanks for all the conversation about this!

* Looks like that rather than Treasuries is the correct spelling.
The wiki has some info on TIPS. The article references https://www.treasurydirect.gov/indiv/re ... s_tips.htm, which says
How TIPS Are Tied to Inflation

Treasury Inflation-Protected Securities (TIPS) are marketable securities whose principal is adjusted by changes in the Consumer Price Index. With inflation (a rise in the index), the principal increases. With a deflation (a drop in the index), the principal decreases.

The relationship between TIPS and the Consumer Price Index affects both the sum you are paid when your TIPS matures and the amount of interest that a TIPS pays you every six months. TIPS pay interest at a fixed rate. Because the rate is applied to the adjusted principal, however, interest payments can vary in amount from one period to the next. If inflation occurs, the interest payment increases. In the event of deflation, the interest payment decreases.

At the maturity of a TIPS, you receive the adjusted principal or the original principal, whichever is greater. This provision protects you against deflation.
That says TIPS are adjusted for actual inflation as measured by a specific CPI index. Does that cover "expected and unexpected inflation" ?

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Re: Difference between short-term TIPS funds?

Post by watchnerd » Tue Feb 25, 2020 12:39 am

sycamore wrote:
Mon Feb 24, 2020 8:50 pm


That says TIPS are adjusted for actual inflation as measured by a specific CPI index. Does that cover "expected and unexpected inflation" ?
CPI is one way to measure inflation, expected or unexpected.

It's what TIPS are adjusted to.
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Re: Difference between short-term TIPS funds?

Post by GettingCloser » Tue Feb 25, 2020 1:19 am

sycamore wrote:
Mon Feb 24, 2020 8:50 pm
That says TIPS are adjusted for actual inflation as measured by a specific CPI index. Does that cover "expected and unexpected inflation" ?
In a word, yes. Expected inflation is just someone's (usually "the market's") prediction of what inflation will be over a given future time period. Actual inflation is a measurement of the inflation that actually occurred in a given past time period. Unexpected inflation is just a term used to describe the difference between the two.

TIPS are adjusted for actual (measured) inflation. Regular Treasury bonds are not adjusted for inflation at all (expected, actual, or otherwise), but they make up for it by having a somewhat higher yield. Choosing between them involves predicting what inflation will be.

Let's say you give me the choice between a 10-year regular Treasury bond yielding 2.0%, and a 10-year TIPS yielding 0.5% above inflation. If I think that inflation will be 1% over that period, I should choose the regular bond, since I would end up with more money that way. If I think that inflation will be 2% over that period, I should choose the TIPS. If I think that inflation will be 1.5%, I might call it a toss-up.

In real life, no one asks you to choose between a 2% bond or 0.5% TIPS -- the market adjusts those percentages up and down in real time, depending on what people are choosing to buy. Regardless of where the numbers come to rest, the difference between them is an indicator of what the market as a whole expects inflation to be for the given time period. That's what we refer to as "expected inflation" or the "inflation breakeven rate".

But expected inflation is just a guess. Once the time period's over, you'll know for sure what you should have bought. If actual inflation ended up being higher than what the market expected, you should have bought the TIPS. If actual inflation ended up being lower than what the market expected, you should have bought the regular Treasury.

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Re: Difference between short-term TIPS funds?

Post by joeschmo » Tue Feb 25, 2020 2:41 am

Thanks all - this is really getting clearer! In this case there is just one remaining question for my IPS: Swensen considers nominal Treasurys a separate core asset class from TIPS and recommends equal allocation to both in his standard portfolio (which, of course, he spends pages telling folks to adapt to their needs). Why would someone want Treasurys over TIPS if their goal is inflation protection? The point of each of Swensen’s asset classes is to provide major diversification benefit. I have heard that Treasurys protect against deflation, but I don’t understand why they’d necessarily do that better than, say, munis.

Thanks again for helping me clarify this mud.

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Re: Difference between short-term TIPS funds?

Post by watchnerd » Tue Feb 25, 2020 10:04 am

joeschmo wrote:
Tue Feb 25, 2020 2:41 am
Why would someone want Treasurys over TIPS if their goal is inflation protection? The point of each of Swensen’s asset classes is to provide major diversification benefit. I have heard that Treasurys protect against deflation, but I don’t understand why they’d necessarily do that better than, say, munis.
You're getting your vocabulary a little jumbled.

Firstly, TIPS are a type of Treasuries, they're just not nominal treasuries.

Nominal bonds of any kind (Treasuries, munis, corporates), can do better during deflation.

Treasuries are assumed to have the least credit risk of any type of nominals.
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Re: Difference between short-term TIPS funds?

Post by joeschmo » Tue Feb 25, 2020 10:31 am

Sorry yes, nominal Treasurys. I've heard that nominal Treasurys in particular are good against deflation and was anyone can point to any sources about how munis perform in deflationary times?

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Re: Difference between short-term TIPS funds?

Post by watchnerd » Tue Feb 25, 2020 10:49 am

joeschmo wrote:
Tue Feb 25, 2020 10:31 am
Sorry yes, nominal Treasurys. I've heard that nominal Treasurys in particular are good against deflation and was anyone can point to any sources about how munis perform in deflationary times?
You're mixing up variables in your question.

Nominal bonds, of all types, have advantages in deflationary times, because their fixed interest rate (from the past) will be better than what is currently on the market.

How well they do depends on the coupon and bond length. Long bonds will do better.

So, for example (assuming all have no credit issues), a long nominal corporate might do better than an intermediate muni or a short Treasury.

The major reason to hold munis is for taxation purposes in a taxable account, and that only matters in high tax brackets. That's their super power. If you don't need that, you can ignore them entirely.
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Re: Difference between short-term TIPS funds?

Post by joeschmo » Tue Feb 25, 2020 11:05 am

All right, thanks. So given high tax bracket and 35% bond allocation and long time horizon, seems I should be fine splitting 50/50 short-term TIPS and interm-term munis. Long-term bonds would be better against deflation risk but the interest rate risk seems a bad tradeoff. And I'll use funds for all these to avoid having to manage a zillion individual bonds. Sound right?

Otherwise I could split the bond allocation 33/34/33 short-term TIPS / interm-term munis / long-term nominal U.S. Treasurys?

But I'm trying to stay simple...

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Re: Difference between short-term TIPS funds?

Post by watchnerd » Tue Feb 25, 2020 11:22 am

joeschmo wrote:
Tue Feb 25, 2020 11:05 am
All right, thanks. So given high tax bracket and 35% bond allocation and long time horizon, seems I should be fine splitting 50/50 short-term TIPS and interm-term munis. Long-term bonds would be better against deflation risk but the interest rate risk seems a bad tradeoff. And I'll use funds for all these to avoid having to manage a zillion individual bonds. Sound right?

Otherwise I could split the bond allocation 33/34/33 short-term TIPS / interm-term munis / long-term nominal U.S. Treasurys?

But I'm trying to stay simple...
Why do you think you need all 3?

No offense, but trying to create a barbell strategy isn't for bond beginners.

Maybe just some short TIPS and intermediate munis.
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Re: Difference between short-term TIPS funds?

Post by joeschmo » Thu Feb 27, 2020 12:47 pm

watchnerd wrote:
Tue Feb 25, 2020 11:22 am
joeschmo wrote:
Tue Feb 25, 2020 11:05 am
All right, thanks. So given high tax bracket and 35% bond allocation and long time horizon, seems I should be fine splitting 50/50 short-term TIPS and interm-term munis. Long-term bonds would be better against deflation risk but the interest rate risk seems a bad tradeoff. And I'll use funds for all these to avoid having to manage a zillion individual bonds. Sound right?

Otherwise I could split the bond allocation 33/34/33 short-term TIPS / interm-term munis / long-term nominal U.S. Treasurys?

But I'm trying to stay simple...
Why do you think you need all 3?

No offense, but trying to create a barbell strategy isn't for bond beginners.
I thought it would make sense to have a balance of maturities, issuers, and inflation vs deflation protection? I want an allocation I can pick and keep for life, so it's not clear to me why I shouldn't take the time now to stop being a beginner and pick the right allocation.

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Re: Difference between short-term TIPS funds?

Post by watchnerd » Thu Feb 27, 2020 12:53 pm

joeschmo wrote:
Thu Feb 27, 2020 12:47 pm
watchnerd wrote:
Tue Feb 25, 2020 11:22 am
joeschmo wrote:
Tue Feb 25, 2020 11:05 am
All right, thanks. So given high tax bracket and 35% bond allocation and long time horizon, seems I should be fine splitting 50/50 short-term TIPS and interm-term munis. Long-term bonds would be better against deflation risk but the interest rate risk seems a bad tradeoff. And I'll use funds for all these to avoid having to manage a zillion individual bonds. Sound right?

Otherwise I could split the bond allocation 33/34/33 short-term TIPS / interm-term munis / long-term nominal U.S. Treasurys?

But I'm trying to stay simple...
Why do you think you need all 3?

No offense, but trying to create a barbell strategy isn't for bond beginners.
I thought it would make sense to have a balance of maturities, issuers, and inflation vs deflation protection? I want an allocation I can pick and keep for life, so it's not clear to me why I shouldn't take the time now to stop being a beginner and pick the right allocation.
What you've created is a mashup of two strategies. It's not the 'right allocation' (there is no such thing).

The usual tactic is either:

Barbell: pick the short and long ends, which weights out to intermediate-ish average duration. You don't buy the middle if you buy the long and short ends:

TBM / Intermediate: you either buy the whole index (which averages out to Intermediate) or just buy the middle

What you're doing is just making a more complex Intermediate fund, at higher cost, at which point you (if that's really what you want) should just buy a total bond fund of either nominal Treasuries / munis (depending on tax bracket) and pair it with short TIPS.
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Re: Difference between short-term TIPS funds?

Post by joeschmo » Tue Mar 03, 2020 8:02 am

In case it helps others, page 250 of CFA Institute's excellent 963-page guide, Managing Investment Portfolios, offers the following helpful info:

Image

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